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Roth options allow US taxpayers to make contributions to their retirement plan from their net earnings, rather than gross earnings. Withdrawals from Roth accounts are exempt from federal income tax, making them attractive to highly-compensated employees. The Internal Revenue Service imposes annual contribution limits on these accounts, and early withdrawals are subject to tax penalties. Most employer-sponsored pension plans offer a variety of investment options, including Roth accounts.
A Roth option is an investment election available to participants in many employer-sponsored retirement plans in the United States (US). Under the federal tax code in the US, taxpayers can generally make contributions to the pension plan on a pre-tax basis. The Roth option allows taxpayers to make contributions from their net earnings, instead of their gross earnings.
Standard pre-tax pension contributions are fully taxable, but withdrawals from Roth accounts are exempt from federal income tax. This means that Roth accounts offer tax savings over traditional pensions, since the earnings in the account are never taxed. While employers can make matching contributions on behalf of employees to standard pre-tax accounts, employers are not allowed to make contributions to Roth accounts. If any employee chooses to take advantage of the Roth option, any employer making matching contributions is deposited into a separate account on a pre-tax basis.
Roth accounts were originally designed as a type of Individual Retirement Arrangement (IRA) into which individuals could deposit a portion of their net income. Unlike employer-sponsored plans, Roth accounts are opened and operated by taxpayers, and income restrictions prevent high-income earners from establishing these accounts. There are no income restrictions on Roth pension plans, which means that employer-sponsored plans with a Roth option are especially attractive to highly-compensated employees.
To prevent people from funneling all their money into tax-free Roth accounts, the Internal Revenue Service (IRS) imposes annual contribution limits on these accounts. Although these limits change from year to year, the maximum contribution limits in Roth pensions are usually higher than the limits in Roth IRA accounts. Some companies choose not to include a Roth option in company pension plans to minimize the administrative costs associated with sponsoring the plan.
Once contributions have been made to a Roth pension plan, participants cannot withdraw from the plan before reaching the national retirement age determined by the IRS. Early withdrawals are subject to a tax penalty, as well as regular income tax. Only account income, rather than participant contributions, is subject to these taxes. In addition to federal income tax, pension plan participants in many states also have to deal with state income tax. In most cases, state authorities do not tax Roth withdrawals with the exception of early withdrawals.
Most employer-sponsored pension plans include several investment options. Typically, these options include a variety of mutual funds and fixed interest accounts. Investors who choose to take advantage of the Roth option can typically deposit their funds into the same accounts as their counterparts who invest in pre-tax retirement accounts.
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